Following the deeply painful years of the COVID-19 pandemic, the senior housing industry has been making a meaningful comeback. Real estate fundamentals for nursing homes, memory care facilities, assisted living facilities and independent living centers regained positive momentum last year. This trend is expected to continue through the remainder of 2023.
Just like any other commercial real estate asset class, however, the heightened inflationary and interest rate environments are impacting the senior housing sector and its financing prospects. For mortgage brokers working with clients in this space, there is much to be aware of when structuring and closing deals.
Positives and negatives
According to Green Street’s recent U.S. Senior Housing Outlook report, senior housing occupancy levels at the national level have recouped slightly more than half of the decline experienced early in the pandemic. At the end of last year, national occupancy was in the high-80% range, about four percentage points below the pre-pandemic level.
The near-term risk of oversupply in certain markets is low as it will reportedly take several years for supply growth to catch up with demand. Rent and occupancy growth is anticipated to average 6.5% per year through 2027. There’s a strong likelihood that the national occupancy rate will reach a new record high, with a forecast average of 92% in 2027. Additionally, net operating income (NOI) forecasts call for sectorwide growth of 20% in both 2023 and 2024.
While occupancy and NOI expectations showcase the post-pandemic resilience and ability of the senior housing sector to rebound, owners and operators are still experiencing significant challenges. Interest rates are an obvious pressure. According to a March 2023 survey of industry executives conducted by the National Investment Center (NIC), 51% of respondents indicated that rising rates are impacting their ability to recapitalize assets. And 36% of respondents cited elevated interest rates as a challenge when purchasing new properties.
As the NIC survey showed, however, interest rates aren’t the foremost challenge faced today by senior housing owners and operators. Rising operational expenses topped this list, cited by a whopping 92% of respondents. Notably, the proportion of organizations that reported rising operator expenses as a significant challenge increased by 15 percentage points from the month prior.
Staff turnover was the second-largest concern, mentioned by 88% of executives. Being able to recruit and hire community and caregiver staff was the third-greatest challenge, with 82% of respondents currently impacted.
Financing outlook
Senior housing certainly isn’t immune from the impacts of the Federal Reserve’s efforts to quell record-level inflation. Although the most recent quarter-point increase this past May (the Fed’s 10th consecutive hike since March 2022) might be one of the last, it took the fed funds rate to a target range of 5% to 5.25%, its highest level since August 2007.
Unsurprisingly, the cost of mortgage debt for senior living facilities has grown in line with interest rate increases over the past year, heavily impacting owners and their assets. In some cases, the cost of debt coupled with the rising cost of construction has delayed timelines for new projects, while in other cases, it has rendered them completely unfeasible.
Additionally, while debt remains available, it is more limited. This has led to a decrease in sales transaction volume, with the exception of distressed assets.
Amid these capital-market dynamics, lenders are now likely to place greater emphasis on the quality of sponsors. Because senior housing is an incredibly specialized field within commercial real estate, ensuring the success of assets typically requires deep market expertise.
Thus, lenders that remain active in financing these projects today are looking to work with owners and operators with experience in the field. They are likely to prioritize opportunities to finance well-maintained and well-managed properties over alternatives, and mortgage brokers can expect more rigid loan qualification parameters, including in facility acuity levels.
Possible path
While many lenders have slowed their activities in this sector, there are financing options available today for numerous types of senior living centers. These include nursing homes, board and care homes, intermediate care facilities and assisted living facilities.
Given an environment in which lenders have either expanded their underwriting guidelines or pulled back on dealmaking, the U.S. Department of Housing and Urban Development (HUD) can be an ideal alternative for owners and operators. While other capital sources adjust and tighten their underwriting metrics in times of economic decline or volatility, HUD financing is countercyclical and its underwriting guidelines do not change.
HUD’s 232 loan program is government-insured financing that offers a fixed rate and full amortization, with the rate determined by market conditions at the time of the rate lock. These loans are nonrecourse and long term in nature — up to 40 years for new or substantially rehabilitated properties, or 35 years for non-rehab acquisitions that can be funded by Ginnie Mae mortgage-backed securities.
The loan review period typically spans 60 days, once the application has been picked up by the HUD underwriter, and the queue is markedly shorter than in prior years. Current interest rates range from 5% to 6%. A mortgage insurance premium is required, equating to 1% of the loan amount at closing and between 0.45% to 0.65% annually.
HUD-approved lending partners will continue to be active at this time, even as others slow or curtail their activities. These capital sources will be an important lifeline for the senior housing industry during this period of economic uncertainty. ●
